Hit and Run Politics: Baltimore City and Maryland State Pensions: A Short History
In March 2006, the Institute issued a Report, The Baltimore City Retirement Systems: Heading for Trouble. The summary at the front of the Report stated:
“The skimming off of surpluses to provide new unfunded benefits in good investment years, together with mediocre or worse investment performance and an escalation of disability claims in the Fire and Police system has caused both funds to go into actuarial deficits. . . These deficits endanger recently granted benefit improvements and sharply increase the annual contributions required of the City, to the detriment of other municipal services… The state funds, which are ten times the size of those in Baltimore City, now have a $5 billion actuarial deficit, half of which is attributable to investment returns below benchmarks in the years 1997-2002, returns among the worst in the country, and half of which is due to the two bad market years 2000-02. The state administration, like that in the City, has failed to make about $267.5 million in actuarially required contributions in the last three years, though these represent less than 1% of the state fund; the City’s by-passed contributions since 1999 aggregate $155 million, about 5% of the two city funds.”
The Report made numerous recommendations for reform, whose status may be summarized as follows:
1. City charter amendment to render retirement funds independent of mayoral control. No action.
2. Reconstitution of Boards to provide more expertise. Reiterated by the Greater Baltimore Committee Fry Report, 2010.
3. Tightening of disability retirement standards. Reiterated by the Fry Report, 2010.
4. Extension of the years of service requirement in the Fire and Police Fund from 20 to 25 years. Reiterated by the Fry Report and implemented by the Rawlings-Blake administration.
5. Conversion of systems to defined contribution systems. Not implemented, but reiterated in the Fry Report.
6. Extension of the Uniform Management of Public Employees Retirement Systems Act, with its anti-conflict-of-interest provisions, to pre-existing funds. Not implemented.
7. Preclusion of race, nationality, and geographic location as investment criteria, or adoption of the Uniform Act provision mandating that “the investment providing these collateral benefits would be prudent even without the collateral benefits.”Not adopted. Instead, Governor O’Malley signed Chapters 601 and 342 of the Acts of 2009 ,mandating ‘affirmative action’ investing and divestiture of investments in specified countries.
8. A legal prohibition on political contributions by pension advisers. No action by City and State administrations, but imposed by the Securities Exchange Commission on June 30, 2010, effective March 2011, after the 2010 gubernatorial election.
9. A housecleaning of the present fund consultants. Undertaken by the Fire and Police Fund, but not by the Employees’ Retirement System
10. A bar against leveraged ‘hedge fund’ investing in view of its speculative nature and high commissions. Not implemented. Instead Governor O’Malley signed Chapter 506 of the Acts of 2009 removing limits on compensation of hedge fund managers and both City and State Boards have embarked on ‘hedge fund’ investing. The State fund’s current asset allocation model includes 10% for real estate, including distressed debt and mezzanine (junior lien) investments, 10% in private equity, and 10% in credit/debt strategies, including junk bonds, multi-state hedge funds, and derivatives.
11. Rejection of proposals for enhanced defined benefit pensions. Instead the legislative leadership proposed, and Governor Ehrlich signed, legislation providing for an increase in such pensions.
The imperfect attention to these warnings and implementation of these suggestions is attributable to the O’Malley administration’s attitude toward unwanted advice. Notwithstanding that the Calvert Report was fully documented, with appendices including relevant statistics and other data, the Mayor’s spokesman Stephen Kearney pronounced that its author “knows absolutely nothing about pension systems. . . This is just a flimsy political attack by a Republican group,”Shay, “Report Takes O’Malley to Task on City Pensions,”Montgomery Gazette, March 31, 2006. while his press spokesman, Raquel Guillory, declared “It was all contrived,”noting that two of the contributors to the Institute had ‘conservative’ affiliations, unpleasant truths being apparently welcome only from those pledging fealty and devotion. The City’s supposed pension expert, former Senator Barbara Hoffman, who had been a member of the Senate’s pension subcommittee during the last years of the Glendening administration when the State fund produced the worst investment results in the nation, declared that the Calvert Report, published more than seven months before the General Election, was the product of “the political silly season.” “City Officials Defend Baltimore Pension Systems,”Maryland Daily Record, March 24, 2006. In fact, the writer of the Report has been entirely bi-partisan in exposure of pension abuses. See G. Liebmann, “Governor Palin’s Pension Party,”Baltimore Examiner, November 2, 2008.
When the Calvert Report was published in March 2006, the actuarial funding status of the three relevant plans was as follows, as of June 30, 2005:
City: ERS 95.7% funded, actuarial deficit $63.7 million
City: F and P 95.9% funded, actuarial deficit $104.4 million
State: 88.2% funded, actuarial deficit $4.613 billion
As of June 30, 2009, the corresponding figures were:
City:ERS 82.6% funded, actuarial deficit $300.7 million
City: F and P 84.8% funded, actuarial deficit $463.6 million
State: 65.0% funded, actuarial deficit $18.444 billion
As will be seen, these figures understate the actual deficits. The calculation of actuarial assets assumes a future post-retirement investment return of 7.75% in the case of the state and 6.8% in the case of the Fire and Police Fund, whose assumed pre-retirement return is 8.25%. The ERS assumes a return of 8.0% pre-retirement and 6.8% post-retirement. The Board of the Fire and Police Fund has discussed lowering the assumed post-retirement rate of return to a still-optimistic 5.0%; its 2009 report notes that this would increase the City’s required contribution by $64 million to $133.5 million, as against $69.5 million provided for 2009 and $48.7 million in 2005. (F and P 2009 Report,6). Required ERS contributions increased from $23.6 million in 2005 to $43.7 million in 2009. The State’s annual required contributions increased from $805.6 million in 2005 to $1.3146 billion in 2009. In 2005, the state failed to make $136.9 million of the actuarially required contribution; in 2009 it failed to make $210.2 million of the required contribution.(State 2009 Report, 40, 76)
Another factor leading to the under-statement of deficits is the actuarial practice of spreading recognition of investment losses over a five-year period. This causes assets to be over-stated following years of large investment loss. Thus, if the present value of state benefits accrued as of June 30, 2009 is compared to the market value of assets on that date, the State’s funding ratio is 60.8% rather than 65.0% (State 2009 Report,74). According to the Minutes of the State Board for
July 20,2010, the State is now considering spreading out the recognition of 2009 losses over a ten-year rather than five-year period, thus further concealing the fund’s true picture from readers of the tables displayed in its report.
How did the City and State funds reach their present pass? A chronological account:
1989
Fire and Police Fund allows retirement after 20 years of service rather than 25, to stimulate retirements for affirmative action purposes.
1991
3% increase in ERS benefits; actuarial cost $35 million.
1993
ERS retirement allowed after 30 years irrespective of age; actuarial cost $26.6 million.
1995
Inauguration of Governor Glendening
1996
Ordinance 42 adds new DROP plan for fire and police, adding $10 million to actuarial liability. $24 million in investment gains is raided to fund the new benefit and absolve the City from $12 million in required contributions.
ERS eligibility period for new retirees to receive post-retirement benefit increases shortened; actuarial cost $58 million, paid for by raiding investment earnings.
Glendening administration encourages affirmative action in selection of fund managers; Nathan Chapman’s fund thereafter breaks even, and another fund, Progressive, loses 43% of value in a five-year period in which peer funds gain a total of 25%. Chapman, and a sub-manager, Alan Bond, later receive criminal convictions.
1997
Ordinance 164 authorizes the City to raid investment gains fo fund required contributions. $10 million is raided for this purpose
1999
Inauguration of Mayor O’Malley
$30.4 million of investment gains are used to replace the City’s required contribution to the Fire and Police Fund
2000
Ordinance 49 provides a 1% increase to present retirees, a 1 year reduction in member contributions, and a reduction of the time period for eligibility for DROP benefits. $61.7 million is withdrawn from the F and P surplus to pay for these new benefits.
2001
New ERS benefits for all classes of membership; new non-line of duty death benefit for members with 20 years of service; lowering eligibility requirements for line of duty disability; reducing workmen’s compensation offsets; new survivorship benefits; $63.2 million, or more than three-fourths of investment surplus, raided to pay costs of new benefits.
July 26: O’Malley votes to reject ERS contract with national firm to encourage local investing; urges consideration of Nathan Chapman, who does not get advisor contract but gets $40,305 in Fire and Police Fund brokerage business.
ERS Annual Report admonishes managers to give preference to local brokerage firms. Percival and Co. receives rising amount of brokerage business: $12,081 in 2001; $83,002 in 2002; $308,021 in 2003; $263,643 in 2004. continuing to 2009, $190,410, receiving more brokerage business from both City funds than any other firm. Its principal, Kenneth P. Taylor, gives $4,000 to Friends of O’Malley during the 2006 election cycle, but nothing thereafter.
At urging of the Glendening administration, General Assembly adopts Chapters 19 and 440 of the Acts of 2002 freezing state contributions to the pension system at the 2000 rate so long as the system is 90% funded, and requiring added contributions of one-fifth the difference between the frozen and calculated rate when system funding falls below 90%( Section 21-304 of the State Personnel article). This authorizes under-funding.
2002
Maryland State Retirement System has a 3.21% rate of return for preceding five year period, as against 5.13% for peer funds, translating to a shortfall in investment earnings of $2.5 billion for the five-year period.(2002-03 Maryland State Budget,vol.I, 582).
F and P replaces Callan and Co. as its investment advisor; ERS makes no change; F and P abandons affirmative action ‘fund of funds’ ERS makes no change. In ensuing two years, F and P achieves a total return of 28.3% as against 22.2% for the ERS.
2003
Inauguration of Governor Ehrlich
State funds only 92% of required contribution; shortfall $52 million.
Federal Medicare Modernization Act of 2003 creates Medicare Part D covering prescription drugs. Notwithstanding that 59% of its retiree health benefits pay for prescription drugs and 76% of Maryland’s retirees are medicare-eligible, state makes no changes in its retiree health plan; it receives a $19 million annual federal subsidy for maintaining in force a plan which now has an avoidable actuarial deficit of $15 billion.
2004
January 6: Former Office of Personnel Management Director Donald Devine, at Calvert Budget Symposium, notes that employee retention rate is the primary Maryland State Retirement Fund performance measure, and that that rate stood at 93 percent, meaning that there is virtually no turn-over and new blood in the state work force (rate was 89.9% in 2009, estimated at 91% for 2011, Maryland Budget, Fiscal 2011,157.).
Fire and Police Report notes investment losses in 2001-03 totalling $412.8 million: ERS Report also notes investment losses may endanger prior benefit increases.
ERS invests $55 million, or 5% of assets, in hedge funds; F and P invests $80 million in hedge funds.In 2009, ERS reports a negative three-year average return of .8% from hedge funds, against negative 2.5% for the total portfolio; F and P reports positive average return of 1.5% against negative 4.5% for total portfolio. Real estate, representing about 10% of each portfolio, produces a five-year average negative return of 3.60 for the ERS, against a positive return of 2.4% for the whole portfolio; a five-year positive return of 4.1% for the F and P, asd against positive 1.8% for the whole portfolio.
State funds only 89% of required contributions; shortfall $78 million.
2005
State funds only 83% of required contributions; shortfall $137 million
2006
General Assembly liberalizes defined benefit teachers’ pensions, generating added actuarial liabilities for state contributions of $ 2.939 billion as against an added $ 791 million in 2005; not vetoed by Governor Ehrlich. The funding ratio deteriorated from 88.21% to 82.78%, almost entirely as a result of this liberalization.
May 18: Board members of ERS chastise Member Glinka for filing a financial disclosure statement reflecting on board travel practices, including travel of several members to Monte Carlo. Board authorizes $10,000 for Groom law firm to conduct a study of travel practices of other large-city boards to justify the Board’s practices.
July 20: ERS board votes to reject motions to reduce individual members’ travel allowances from $10,000 to $7500 annually; re-adopts $10,000 limit with new restrictions limiting each member to one international trip per year and prohibiting attendance by more than three trustees at any one conference.
July: State creates Commission to Study Retiree Health Care Funding Options, with mandate to deliver interim report by December 2008 and final report by December 2009.
State funds only 82% of required contributions; shortfall $157 million.
2007
Inauguration of Governor O’Malley
State funds only 81% of required contributions; shortfall $195 million.
State estimates its retiree health obligations at from $14.977 billion to $15.193 billion. Cato Institute estimates a $20.4 billion liability; Credit Suisse estimates liability at $22.9 billion. Credit Suisse estimates Baltimore City liability at $2.7 billion. State appropriates $255.9 million for PAYGO funding of retiree health care, an increase from $109.8 million in 2002 and $79.8 million in 1998.
2008
State funds only 89% of required contributions; shortfall $105 million.
State fund earns yield over previous five years of .48% less annually than peer funds (over $ 1 billion)
Department of Legislative Services Ninety Day Report (p.A-17) notes that actuarial error adds $70 million in teachers’ retirement costs for year. Report notes that annual teacher retirement costs will grow in 2009 from $566.4 million to $621.8 million, an increase of 9.8%, mostly due to an 8.8% increase in the salary bases for local boards of education due to seniority increments not accorded to non-school-system employees.
Governor O’Malley signs S.B.601 mandating affirmative action for investment managers (Sec.21-116(D)(1) of the State Personnel article).
Governor O’Malley signs Chapter 342 mandating divestiture of stock in companies doing business in Iran and Sudan (Sec. 21.123(1) of State Personnel article)
Governor O’Malley signs Chapter 506 of the Acts of 2008 lifting the former 1.2% cap on fund manager compensation, Section 21-315(d)(2) of the State Personnel article. “The Board of Trustees is not limited in the amount of investment manager fees that the Board of Trustees may pay as necessary for external real estate or alternative investment management services.